Small Cap Value Report (Fri 17 Feb 2017) - DRV, TRCS, BBSN, AVAP

A very quiet news day today, but I'm sure we'll find something interesting to discuss. Also, Graham has emailed me a section on Jarvis Securities (LON:JIM) results from yesterday, which I have added to this report. Thanks Graham, I know that is a stock that several readers asked us to report on.

Results y/e 30 Sep 2016 - it's taken 4 months and 17 days to produce these accounts, and they're not even audited yet. That's a really bad start. Good companies don't deliver accounts this late.

Mind you, after just reading the first few paragraphs, it's clear that things have been in a mess at this company - with changed management, and problem levels of debt.

I last reviewed this company in May 2016, and came to the conclusion then that the bank borrowings looked worrying. Also I disliked the large receivables balance, and noted a bad debt write-off, and change in CEO.

The highlights make it sound as if the operating loss was modest, at £0.2m, but just look at all the adjusting items below. Horrible!

Balance sheet - this looks pretty dreadful too. Net assets are down sharply to £7.6m, of which £4.1m is goodwill & other intangibles. So NTAV of only £3.5m.

Given the enormous debtor book, which has risen to £20.3m, that leaves a gap on the balance sheet which has been filled by bank borrowings - net debt is £9.9m. Although it looks as if the bank has had enough, and forced the company to repair its balance sheet (see details of equity fundraising below).

Turnaround? - today's results highlight that H2 was improved against H1, costs have been cut, and the business reorganised. On current trading, the company says that H1 to date is better than last year;

First 4 months of new financial year comfortably ahead (by £1.1m at an underlying* profit before tax level) of prior year and ahead of internal forecasts

Sounds good, until you check to last year's interims, and discover that it made a £1.5m underlying loss. So this implies that the business is still marginally loss-making now. That doesn't strike me as much of a turnaround, yet.

Outlook - further comments promise improved performance…

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Driver Group Plc (Driver) is a United Kingdom-based company, which provides consultancy services to the engineering and construction industries. The Company conducts its operations through three operating divisions: Europe & Americas (EuAm); APAC, Middle East & Africa (AMEA), and Initiate. The EuAm and AMEA divisions provide various services, such as quantity surveying, litigation support, contract administration, and commercial advice/management. The Initiate division offers development, project and contracting management services to the infrastructure market in the United Kingdom. DIALES is its witness support service provider. Driver Project Management provides the strategic and leadership disciplines necessary to develop and deliver a project. Driver Project Services provides customer-focused project controls solutions across a project lifecycle. Driver Trett provides multi-disciplinary consultancy services to support delivery of its clients' projects. more »

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1) Book value is 240p : Sales of portfolios of aircraft go for a reasonable premium to book value and AVAP will only sell at a material premium. They have multiple bids and are in continuing discussions with some. Suggests to me that bids are not a million miles away from management expectations of worth or they would just can the process and get on with existing business..........

..........which is great

2) Management have done an excellent job as far as I can see in reducing aircraft average age and increasing length of contracts. I understand that with all aircraft the purchase costs (and thus debt) are matched to a lease contract and interest rate risk is eliminated at a fixed spread......this is great as there are no expensive hedging instruments and no interest rate risk borne by the business. I like this in a business - AVAP core expertise is not in managing interest rate risk it is in managing aircraft leasing!!!

So a fwd PE of 7 on a business trading probably 20-30% below its breakup value...........I remain unsure as to why the market is muted in its reaction as I feel this should trade closer to £3 personally. However, I was equally unsure when I bought them at £1 why they weren't trading at £2, and now they are, so I guess the market just takes time in giving the benefit of performance. A slow re-rating rather than a rapid one.

I suspect this is 3 fold

1) Credit risk - clearly they lease to airlines; a few of which, have had an annoying habit of going bust at the merest sniff of recession (and I'm not talking about just the small ones). This could cause trouble were it to happen to any of their major customers if the leases cannot be enforced.

2) Debt : Not sure people quite believe they are not exposed to interest rates directly and continue to fret about a rising rate environment increasing their finance costs as well as high levels of debt.

3) Listed here but really a Singapore company - a number of institutions won't invest

Unless I've misunderstood you've missed the key risk, Residual Value, shareholders have good reason to trust mgt but the macro economic picture can make even conservative RV's look dangerously ambitious over lengthy lease periods. Being braver than other lessors on RV expectations is the key way lessors gain market share so there is a constant pressure to push the envelope of what's prudent .

Aircraft type risk exists as well, IIRC a lot of lessors got badly burnt when desperate manufacturers forced volume from unpopular airframes into the market to the detriment of any pre existing lease arrangements. Just look at the issues Flybe have with their 'wrong model" Embraers as an indicator of what can go wrong.

Avation (LON:AVAP) NAV $3.10 technically. It's possible to say, given the amount of leverage, that the business is not worth much more to the public markets than its NAV, but I agree, having listened to the results and short Q&A yesterday, that they have so far delivered in spades. Given the recent aircraft delivered, the second half must be better than the first half, but it's the fleet age reduction to 2.8 years, with leases running to 7.8 years that convinces me not to sell. I thought I would bank some profits this week, but I shan't, as they certainly seem worth £2.50 as they have spread their risks well. And if a big lessor wants to deploy money, yup, I think they'd have to pay at least £3 to buy Jeff Chatfield out.

Were you not tempted to sell immediately Gus? I think you are right that odds are stacked against falling knives and in my view the Stockopedia research suggests you should pretty much always sell straight away and ask questions later. Do you have reason to believe fears are overblown? I noticed they mentioned increased price competition which would be troubling for me.

I was quite proud of myself not to jump in and buy when the shares fell after the first day on what was in effect a warning about a possible profit warning. Selling would have been a bit too much given the lovely, cheap bargain price that the beautiful Tracsis (LON:TRCS) shares were being given away for .... damn, still can't break the bad habits, You're right, I probably should have sold first thing ...

These are good points and I am at a loss to understand why the shares are not flying upwards, am trying to fund some coverage elsewhere to see if anyone else can shed any light. Paul certainly covered this stock once maybe he has no further interest or maybe just jet lag. A non related stock I own marstons mars also I feel should be higher but I guess its biz rates and min wage fears keeping it depressed. Unlike some boards these guys seem to be acting in shareholders best interests so I am happy to stay in but I guess if the world bubble bursts then these could be hurt but that said so will may stocks

I listened to the call yesterday and to me it's pretty clear that Avation (LON:AVAP) management aren't keen to take the offers that have been made on their ATR fleet, which is half of the business. So maybe the prospects of a quick input of cash have reduced and that is removing a premium from the share price.
I support the management view and would prefer to hold for the long term.

Re: AVAP
I agree with all the other comments on AVAP. And the points about controlling interest rate risk by matching borrowing and lending periods (comment 11) is really important.
I also listened to the H1 results webcast. They do sound as if they know what they are doing. And, on the possible sale of their ATR fleet, the choice should be simple. Only if it is a better option than keeping the fleet and earning several years of profits from it.
The stock report shows a forward p/e of 7.6. If I am right this is prior to any upgrade to forecasts after these results. So if H2 is as good as they suggested in the webcast - including half year earnings for new planes acquired and leased out during H1 - then the p/e could easily drop to 4 or 5. I am happy to hold and wait for the market to notice this and bring the p/e back up to 7 or even to allow some sort of growth premium.
Sometimes it's worth sticking to our convictions even if the market doesn't see it. Unless we've got it wrong!

Thanks for the comments on Jarvis Securities (LON:JIM). I haven't held it all that long but I like the potential here.

I suspected there would be an uptick in the company's fortunes when £HL reported Q3 Y-o-Y increases in client initiated trades of 40%+. Sadly, Jarvis aren't leveraged to the upside in the same way and they don't make the obscene custodial fees that HL charge.

This is really two businesses in one. The transaction administration business is usually loss making except in unusually good market conditions. Fees & commission income in 2016 was £4.8m and admin expenses were £4.7m, so a small profit (assuming all costs are related to fees and commission income). But the £3.5m in interest earned has to be nearly 100% margin, a bit like a royalty stream.

The company discloses KPIs at the half year which include growth in cash under administration. They haven't disclosed the actual level of cash under administration for several years but if you go back to when they did report it and use the since reported percentage increases, you can get to the actual number. According to my calculations, it was about £182m as at 30 Jun 16. It's good to hear that it is presently at "record levels". The 5 year CAGR (to 31 Dec 16) for interest income is 11.4%. The 5 year CAGR (to 30 Jun 16) for cash under administration is 21% (aided by stellar performances in the year to 30 Jun 13 and year to 30 Jun 14 but still above 10% more recently). This evidences the compression in net interest margin. Despite this, the 5 year CAGRs (to 31 Dec 16) are 8% for revenue (11.4% for interest earned and 5.9% for fees and commissions), 14.2% for diluted EPS (enhanced by occasional repurchases of shares and very few outstanding options), and 11.8% for the dividend (excluding 10p special in 2015).

A note of caution on the net interest margin. Jarvis have a very high net interest margin - it looks to be in the vicinity of 170+ bps (down from about 300 bps pre 2008). HL have guided for 2017 net interest margin of about 40-50 bps (from memory). Share Centre have made comments in recent results about other market participants earning more net interest margin by entering into agreements with counterparties that Share Centre consider too risky. These Share Centre comments are likely directed at Jarvis. A counterparty default would be catastrophic. This risk is counterbalanced by the fact that the Chief Executive would suffer enormously as a very significant shareholder.

Costs appear to be normally very well controlled. Shareholders on the register report elsewhere that the annual report is a stapled photo copy and not a glossy item. The company said in 1H16 that they were in discussions on several material proposals. In 2H16 they said they had entered into heads of terms. It's possible that they have had to incur upfront expenses. Just a guess.

The bullish company comments on market conditions are welcome. And, as the company says, even a small imcrease in interest rates could have a material positive impact on net interest margin.

Having been a shareholder of Avation (LON:AVAP) for a number of years I thought I would weigh in my thoughts on this company.

I largely agree with what other posters have mentioned in respect to the company. This is a case whereby what the company has been doing for a number of years has resulted in continual good to excellent performance but the share price has not reacted accordingly. There are several factors for this in my opinion.

Firstly they are a very small leasing company in comparison to the rest of the world; a minnow. Secondly, as evidenced by continual 'meet and greet' retail investors by the FD they have yet to find a genuine industry related shareholder on the register (although I do accept this has improved over time); this means fickle shareholders like us move in and out of the company on a regular basis. Thirdly they are listed on the wrong exchange; this is not the sort of company that will get recognised on the LSE. Moving to NY or Singapore exchange would be beneficial and I suspect long term that is their strategy particulaly now that everything is reported in USD.

So, very well run company but share price driven by credit ratings (improving), fleet size and retail investors.

Last year the company was approached initially by non-aviation sector private company to buy the ATR fleet. As the company was (and always has) been trading below book value a sale at or above book value obviously increased the share price by a large percentage. It's important to note that Avation did not market the fleet but someone came to them. As news spread about this offer it attracted a number of other parties to get involved. Given this is half the asset value of the company they were duty bound to take these offers seriously and hence engaged an experienced third party to handle it.

At the time Avation were of the mind that perhaps their business model could change somewhat and get into the business of creating aircraft fleet asset packages to be sold off above acquisition costs i.e. become more of an aircraft trader than a lessor. There are a number of so called ready made fleets out there which with Avations' experience and knowledge they could readily acquire. That was their initial reaction anyway...

As time has gone on it seems apparent to me that their concern is that they wish to stay in the narrowbody market but valuations are very high now and the idea of buying ready made replacement fleets is not as easy as they initially thought. Therefore the loss of revenue and profits over the years it will take them to increase the fleet size again means that a massive premium would be required on the fleet sale. with 97% of their loans at fixed rates that alone is a powerful argument to keep things as they are in a rising interest rate environment (next 14 years). Given the ATR fleet growth is going to be pedestrian and the yields on the jet fleet are relatively smaller then perhaps it is wise to keep the ATR fleet unless someone came up with a huge premium. A premium is one thing but a huge premium of >30% is quite another.

However they are into aircraft sales and selling a few ATR's, the older -500 series is in line with normal trading.

So it's all good for the company and the business but given the share price appreciation when the ATR sale was first announced I am certain there will be a meaningful fall in the share price if they announce the fleet sale is not going to happen; perhaps mitigated if at the same time they have secured sales on only part of the ATR fleet.

As a consequence I sold about a third of my substantial holding. However long term I'll probably be a buyer following the announcement of a failed ATR fleet deal because plugging various numbers into my finance model shows that full year profits are going to be good and I do believe in this company over the long term.

Whilst it is very easy to work out future revenues (I've been within 3% of actual for the past three years) profits are unduly affected by loss/gains on aircraft sales which cannot really be regarded as 'exceptional' at all because it is part of their core business. This year on year variability means that those forecast EPS figures can be materially affected.

Therefore, this company which is an asset trading company should, in my opinion, be priced on the value of the assets adjusting for finance risk, operational risk etc and depreciation; which means to me that a 1.5 valuation over book value is a fair valuation of the company.

yeah I agree i think short term would be great, but then how long will it take them to build up a decent size fleet again. Seems a bit short sighted to accept such an offer. Although they did comment there was around 8 potential offers on the table, which gives a clear indication of demand out there at the minute, Holding out for now but i will consider selling if a off is accepted.
Sean

Assuming you mean Jarvis Securities (LON:JIM) in which case I entirely agree with you. Revenue +25%, FY17 PTP to be "significantly above current market expectations" and quarterly dividend raised to 6p from 4.25p same period last year. Cracking news.

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for Stockopedia.com on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »